Employers planning to shift staff from a defined benefit (DB) pension to a defined contribution (DC) plan need to keep a careful eye on the wording of their documentation. Fortunately, a recent legal decision opens the door for amending the paperwork for existing plans.
On Aug. 7 the Supreme Court of Canada ruled in favour of the employer in Elaine Nolan et al. v. Kerry (Canada) Inc. et al — better known as the Kerry case — essentially approving both the use of DB plan surpluses to pay for DC plan liabilities and the payment of operating expenses from plan assets.
“This decision says [that] in many cases it will be proper to amend your plan to start adding DC plan members and to use existing assets to help cover the contributions for these members,” says Paul Timmins, senior consultant at Watson Wyatt. “The caveat is if the whole thing is structured properly.”
When opening a DC plan for new hires, employers that have previously offered DB plans must be careful to structure the DC stream as a component of the same pension plan as the DB stream.
“The people who participate under the DC provisions are still participating in part of the same overall plan,” says Timmins. “They are entitled to accrue benefits using some of the assets from the existing pension fund. I think what this decision says is that, as long as you put that together properly, then this is a permissible practice.”
Communications must make this dual-stream clear to existing plan members, Timmins says. Too often the DC stream of the plan will be referred to as “the new plan,” which may confuse members.
“They are two different kinds of benefits accruing, but they are under the same plan. It’s important to make clear that the plan already exists, and that you’re going to modify it going forward to provide benefits to new hires or people who switch over, but it’s still part of the same plan.”
The Kerry decision will apply to virtually every company considering the switch from DB to DC, unless the original plan was so rigidly structured as to state that surpluses could only be used for the benefit of DB plan members.
“Having said that, I would never write a plan that way and I don’t recall ever seeing one that was so restrictive,” says Timmins. “I’ve never seen wording that wouldn’t allow you to expand the types of benefits that accrue in the future.”
Suggestions that the Kerry decision sounds the death-knell for the DB model are overstating the importance of the case, he says. Corporate finance is the primary consideration for employers contemplating a switch to a DC plan.
The volatility of expenses and how they show up on the balance sheet, combined with the asymmetry of risk, which forces sponsors to make up any losses in a DB plan, are the most compelling drivers of the change.
“The ability to use surpluses from the defined benefit part of the plan to make defined contribution transfers is a nice frill, but it’s not a key decision-maker,” Timmins says.
“There is some hope right now, that the move out there for reform, brought on by commissions and reports, [could result in] the regime for running a pension plan could become more employer friendly.”
As the Kerry case moved through the legal system, some employers have followed the company’s lead on the understanding that it was a permissible practice. The worst case scenario would have been for the Supreme Court to rule against the employer, which would have meant those companies would have had to repay the money to the DB plan.
“For a few employers, maybe this is what they were waiting for to start [using DB surpluses to fund DC plans], but maybe in the meantime their DB surplus disappeared with the market drop.”
The more pressing matter in the Kerry case is the payment of plan operating expenses out of the pension fund, Timmins says. This practice is far more common than the sharing of surpluses, and a ruling against Kerry would have forced many more companies to repay these costs.
(08/10/09)